Magazine

Kraft's IPO: Not Too Cheesy

June 10, 2001

Loretta Nedved, a retired nurse and small investor in the Sacramento Valley town of Elk Grove, Calif., has been waiting for months. Back on Wall Street, big-money pros such as Robert Doll, global chief investment officer of Merrill Lynch's funds group, are feeling just as expectant. What's uniting these two and legions of other investors? Anticipation of the mid-June initial public offering of stock in America's No. 1 foodmaker, Kraft Foods.

You can thank (or blame) Kraft for such stuff as Tang, Jell-O, Oreos, Cheez Whiz, and Oscar Mayer Lunchables. Its stock is going public courtesy of Philip Morris, which you can thank (no, blame) for Miller Lite and Marlboro. Philip Morris assembled the food giant over 15 years via mergers with General Foods, Kraft and, late last year, Nabisco. Now, it is selling 16% of Kraft for about $8 billion.

This mega-IPO, Nedved told me, is a chance to buy into a company "that has been around for a while and has good things behind it"--unlike so many of last year's tech IPOs. Doll, whose funds own Philip Morris (MO) stock, said the deal "will do nothing but accentuate the value" of the food assets that are locked inside the tobacco company. Yet for many investors everywhere, the question remains: Is Kraft coming to market at a price that's any more tempting than a plate of Velveeta?

At first glance, I would have said no, and not just because most IPOs wind up losers. Kraft's indicated share price, $28.50, works out to a market value of nearly $50 billion, or 35 times what the company would have netted in 2000 had it owned Nabisco for the full year. Yet after looking at its financials and those of its leading rivals, I think Kraft holds some hidden attractions.

In scope and scale, Kraft has just one, maybe two, rivals. With sales of $35 billion in 140 countries last year, it dwarfs all the familiar U.S. food names. H.J. Heinz is a distant runner-up with $9.3 billion, while Europe's Unilever, splitting its $44 billion business evenly between food and cleaning products, probably qualifies as a peer. But it is Switzerland's Nestle, the world's biggest food company, that Kraft must best to reach its goal, made explicit in the prospectus, of being "recognized as the undisputed leader of the global food and beverage industry."

CRUNCHING NUMBERS. So, how does Kraft compare with Nestle? Last year, Nestle's sales grew 9%, to $50 billion. Sales at Kraft, assuming it had owned Nabisco since the start of 1999, rose just 1%. But from there, Kraft begins to look better. Nestle's 2000 earnings grew 22%, to $3.5 billion. With Nabisco, Kraft would have seen 26% growth in net profit, to $1.4 billion. More striking is Kraft's superior efficiency. Its operating profit margin last year, 13.2%, came in two percentage points fatter than Nestle's (NSRGY). Look at it this way: Nestle's 225,000 employees generated an average of $25,000 in operating profit, while each of Kraft's 117,000 employees made $39,000 (table).

Kraft brings less of its revenue to the bottom line than Nestle because past acquisitions have left an expensive legacy of interest costs and goodwill amortization. The first burden will lighten after the IPO, as Kraft uses the proceeds to repay half the $15 billion it borrowed from parent Philip Morris to buy Nabisco. With its debt cut that much, Kraft last year would have saved $601 million. And if a proposed U.S. accounting rule change is adopted, Kraft will no longer have to amortize goodwill regularly from next year on. Quarterly charges for goodwill, including Nabisco, would have cost Kraft $961 million in 2000. Those savings together come to more than Kraft-Nabisco earned last year.

Don't get me wrong here. I'm not saying Kraft is the cheapest stock on the block. It is set to sell for 13 times last year's cash flow, or 1.4 times sales. But Nestle goes for 16 times cash flow, 1.8 times sales. True, Nestle is independent and Philip Morris will still control Kraft. But if you're shopping for a global food giant, Kraft looks like the bargain brand. By Robert Barker